Take my money, please!
That's the mantra at several pension funds rushing to reach their private equity targets. Like the late comedian Henny Youngman pleading for someone to take his wife, many pension funds are practically begging general partners to hurry up and invest their cash so sponsors can hit their marks.
Achieving those goals has been no laughing matter. In fact, the difficulties in reaching them have intensified in the past year, because distributions from private equity investments are coming back faster than ever due to the soaring stock market, which in turn lowers the allocation.
The solution for many pension funds is to overcommit in the asset class in order to bring them up to target.
That's been the strategy for the last year at AMR Investment Services, Fort Worth, Texas, which manages the $12 billion pension fund of American Airlines Inc. William Quinn, president of AMR Investment Services, said that while the $6 billion defined benefit plan has a target allocation of 6% in private equity, it only has around 4% invested. "We're not getting close to where we want to be, and so we are willing to commit up to 10% to get invested in the asset class," he said.
He added that it takes longer to reach the goal with some general partnerships than others. "Some firms like Hicks Muse Tate invest your money the next day. Others can take five to six years, which is part of the problem," said Mr. Quinn.
"Now that distributions are coming back so quickly, we have opted to try this (overcommitting) as a way to get more money invested sooner," he said.
Parag Saxena, managing director, private capital at INVESCO, Atlanta -- which manages $2.4 billion in private equity investments -- has devised a formula to help clients reach policy allocations.
"If they want to invest $1, they need to commit between $1.60 and $2.20, depending on a number of variables."
Those include how fast the money is drawn down, what rate of return the investor wants, and what the pension fund allocation to private equity is, said Mr. Saxena. "Now, a newer problem has developed, because distributions are coming back faster, due to e-commerce and telecom. That means pension fund money not allocated to private equity is growing at a faster than normal rate because the public markets have done so well. It used to be that early-stage venture capital investments had a long gestation period, and distributions were returned in three years. Now they're being returned after two years or less.
"For example, a $100 million fund growing at 20% becomes a $120 million fund raising a 5% private equity allocation to $6 million from $5 million. To commit 1.6 to 2.2 times $5 million, the fund would have needed to commit $9 million to $11 million. But because the $5 million has become $6 million, the pension fund would have to commit between $9.6 million to $13.2 million to get 5% of assets invested. As a result, a number of our pension fund clients have been raising their commitments to private equity," he said.
However, there is a downside to overcommitting, observed Robert Woodard, chief investment officer, Kansas Public Employees' Retirement System, Topeka.
"It creates a certain urgency which may not be particularly healthy. Because you work hard to get exposure, you may not be as judicious as you should be about selecting partnerships," he said.
The $9.2 billion fund has doubled the amount it actually wants to commit, committing at the rate of $200 million a year, to get to its policy target of 5%. Even so, the program which is two years old, is only 1% invested and Mr. Woodard estimates it will take eight to 10 years to reach its target.
"Now we're at the point where we could accelerate or decelerate the program, based on the expectations of the capital markets. Since there is so much money going into this asset class, returns could be lower if the trend continues,"Mr. Woodard said.
As a result, the system is discussing decelerating. "We may try to be more particular, more focused. We are significant players now, and can afford to pick the best of the best."
Other pension funds have already scaled back commitments. The $153 billion California Public Employees' Retirement System, Sacramento, last year decided to reduce its private equity allocation to 4% from 5% because it couldn't put the money to work fast enough, said Brad Pacheco, spokesman at the fund. The target is still 4%, and about 3% is invested, Mr. Pacheco said. Currently CalPERS has 117 partnerships valued at $7.5 billion in commitments, of which $4.1 billion has been invested.
AMR Services' Mr. Quinn voiced concerns similar to those of Kansas' Mr. Woodard about being selective while building up commitments. "We don't want to just throw money out to get invested," he said. "We won't go into first-time funds, because we want to be able to gauge how they will do. We will only invest with firms that have substantial equity and good track records."
Venture cap undercommitted
At Los Angeles County Employees Retirement Association, Pasadena, the main issue has been getting enough capital committed to the venture piece of the private equity portfolio, said David Locke, senior investment officer, alternative assets. It's a problem particularly with very early stage funds that only want to raise a total of $20 to $50 million.
Currently the $25 billion fund has 83 partnerships and 65 general partners, which is a lot to keep track of. However, Hamilton Lane Advisors Inc., the pension fund's private equity consultant, does much of the monitoring of the buyout portion of the portfolio, which has a target allocation of 60% of private equity assets.
"But we can't get close to our venture capital commitment of 20%," Mr. Locke complained. As a result, the system is about to hire INVESCO for its fund of funds strategy, which offers access to top venture cap funds not available to Los Angeles County on its own, said Mr. Locke.
"We are constantly reassessing this and could also decide to leave our target allocation at 20% while investing nothing," he continued. The irony is that Los Angeles County did have access when the alternative program was new in the late '80s, and it invested in Kleiner Perkins Caulfield & Byers LP -- widely considered the Cadillac of venture cap managers.
But times have changed and Los Angeles County no longer offers any competitive advantage to hot funds like those, said Mr. Locke. "They can be very selective about who they want as a partner. We have no cachet, no deal flow. We only bring money, but we're a negative, particularly because we are a public fund that uses lawyers and asks for special terms."
"Funds like that prefer to work with people who will keep information confidential. They fear their reports could become public. Part of the problem is all that money that's trying to get in, so we're being selected out. They prefer to deal with endowments such as MIT, which might offer deal flow, or even former entrepreneurs they have backed who are now in a position to be their investors. That's the main reason to use a fund of funds that does have access if we don't."
Since starting the alternatives program in 1986, the system has committed $2.7 billion, and drawn down $1.74 billion. The invested portion stood at $766 million as of Dec. 31, because a lot was distributed. The system wants the program to be at $1.5 billion, and it could get there by committing $360 million a year, Mr. Locke said.
Not every pension fund with an alternative allocation has to worry about reaching a set target.
General Motors Corp., New York, doesn't even have a policy allocation for its private markets portfolios. "We don't have explicit targets, which allows us to be opportunistic," said Charles Froland, managing director for private markets at General Motors Investment Management Corp., which manages GM's $75 billion in pension assets.
"Our allocations are judged by investments and what's appropriate relative to the opportunities we find, so there is no percentage target we have to maintain. That puts less pressure on us to manage to a precise mix," he said.
"We base our decisions about a fund on the general partner; how much we want in a particular fund; how much we want to commit to the investment strategy."
Most pension funds are using a similar formula in setting alternative asset goals, Mr. Froland believes. They have target allocations that range from 4% to 7% or 8% of assets. GMIMCO currently has 5% of assets invested in private markets.
"We don't feel pressured to raise it a lot. I'm mindful of where we are in the (investment) cycle, which has been very good for some time. We can't time the market, especially in areas such as venture cap, because the IPO market is frothy. We're seeing lots of good opportunities. Many are pricey. Distributions are coming back faster and it's possible we have less invested than usual," he said.
But the strategy remains the same, Mr. Froland emphasized. "We're not committing a lot one year and less the next year. We want to commit on a steady basis, to be in this market in a significant way," he said.
Nor are targets the issue at the State Board of Administration of Florida, Tallahassee. Around 90% of the fund's commitments to alternatives were made in the last three and a half years, said Frank Fernandez, assistant portfolio manager for private equity. The $95 billion system's program is still very young.
"We're putting out a lot of money at this point, but not getting a lot back yet, so we have the opposite problem of most funds. Around $1.7 billion of a $3.2 billion commitment has been invested, to date, Mr. Fernandez said. He predicts that there could be a problem maintaining a good allocation by the time 2000 and 2001 roll around.
"It will depend on how fast the managers turn around the money," he added. "At this point we don't have any target allocation, but we do have a limitation on private equity investments, which is 5%. of plan assets, or just under $5 billion."